Monday, May 19, 2014

The Optimal Durability of Location Fixed Capital and the Turtle Economy

Everything has a finite life.  Pieces of capital such as; your car, your phone, your computer, your home, yourself, the building where you work, the highway you drive on, the subway that goes downtown all will eventually crumble.   Economists write down simple accounting depreciation rules for modeling how much of the "iceberg" melts each period unless you invest to reverse such depreciation.

To help us to adapt to climate change, how durable should our building and urban transport infrastucture be?
The point of this blog post is that our current capital stock is too durable.  We should be building buildings that last for 15 years.

There is a place called the South Tip of Manhattan and it has a built up infrastructure (the subway was built in roughly 1912) and hundreds of old buildings.  This old capital was built at a time of inferior engineering techniques and at a time when Sea Level Rise was not a concern.   If this capital plays a key role in underpinning the productivity of one of the world's major cities, then we are holding a risky portfolio.

Contrast this with the case in which the capital stock is less durable. Suppose we admit that we know that we don't know what the future will be like and we build a capital stock with a life expectancy of 15 years.  This would mean that in 15 years time, we will need to rebuild the obsolete infrastructure.  

We would face the following tradeoff.  By building the fifteen year capital stock, we would pay lower upfront fixed costs for each project and we would have an option at the end of that time to rebuild at the same place using the future technology or to move to higher ground.  A life cycle materials researcher would say that energy would need to be used each time to build the new structure and this is true but I imagine that the materials used in the structure could be recycled and brought to a new location.

Our organized retreat from flood affected areas will be cheaper if expensive sunk capital isn't stuck there.

My proposal for shorter lived capital would also affect urban politics.  Spatial subsidies for sea walls using other people's money would be less likely to be supported if there is agreement that the "victims" located in the flood area can move themselves and their building to higher ground.  Similar to turtles, we need to take our shell with us to higher ground.

The point of this blog post is that existing physical capital such as buildings represent a sunk investment whose value falls sharply in the face of sea level rise.  The people who own these buildings will claim that they are victims and will want a tax payer bailout.  But, are they victims?  If we introduce capital investments that embody more option value (and short lived buildings achieve this) then future shocks cause less social damage.